Mattel 2006 Annual Report Download - page 54

collectibility of accounts receivable of customers deemed to be a credit risk, including requiring letters of credit,
factoring or purchasing various forms of credit insurance with unrelated third parties or requiring cash in advance
of shipment.
The following table summarizes Mattel’s allowance for doubtful accounts at December 31 (in millions,
except percentage information):
2006 2005 2004
Allowance for doubtful accounts .......................... $ 19.4 $ 24.6 $ 32.8
As a percentage of total accounts receivable ................. 2.0% 3.1% 4.1%
Mattel’s allowance for doubtful accounts is based on management’s assessment of the business
environment, customers’ financial condition, historical collection experience, accounts receivable aging and
customer disputes. When circumstances arise or a significant event occurs that comes to the attention of
management, such as a bankruptcy filing of a customer, the allowance is reviewed for adequacy and adjusted to
reflect the change in the estimated amount to be received from the customer. Changes in the allowance for
doubtful accounts between December 31, 2006 and 2005 reflect management’s assessment of the factors noted
above, including past due accounts, disputed balances with customers, and the financial condition of customers.
The allowance for doubtful accounts is also affected by the time at which uncollectible accounts receivable
balances are actually written off.
Mattel believes that its allowance for doubtful accounts at December 31, 2006 is adequate and proper.
However, as described above, Mattel’s business is greatly dependent on a small number of customers. Should
one or more of Mattel’s major customers experience liquidity problems, then the allowance for doubtful accounts
of $19.4 million, or 2.0% of accounts receivable, at December 31, 2006 may not prove to be sufficient to cover
such losses. Any incremental bad debt charges would negatively affect the results of operations of one or more of
Mattel’s business segments.
Inventories—Allowance for Obsolescence
Inventories, net of an allowance for excess quantities and obsolescence, are stated at the lower of cost or
market. Inventory obsolescence reserves are recorded for damaged, obsolete, excess and slow-moving inventory.
Management believes that the accounting estimate related to the allowance for obsolescence is a “critical
accounting estimate” because changes in the assumptions used to develop the estimate could materially affect
key financial measures, including gross profit, net income and inventories. In addition, the valuation requires a
high degree of judgment since it involves estimation of the impact resulting from both current and expected
future events. As more fully described below, valuation of Mattel’s inventory could be impacted by changes in
public and consumer preferences, demand for product, or changes in the buying patterns of both retailers and
consumers and inventory management of customers.
In the toy industry, orders are subject to cancellation or change at any time prior to shipment since actual
shipments of products ordered and order cancellation rates are affected by consumer acceptance of product lines,
strength of competing products, marketing strategies of retailers, changes in buying patterns of both retailers and
consumers and overall economic conditions. Unexpected changes in these factors could result in excess inventory
in a particular product line, which would require management to make a valuation estimate on such inventory.
Mattel bases its production schedules for toy products on customer orders and forecasts, taking into account
historical trends, results of market research and current market information. Mattel ships products in accordance
with delivery schedules specified by its customers, who usually request delivery within three months. In
anticipation of retail sales in the traditional holiday season, Mattel significantly increases its production in
advance of the peak selling period, resulting in a corresponding build-up of inventory levels in the first three
quarters of its fiscal year. These seasonal purchasing patterns and requisite production lead times cause risk to
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